The T-Report

For the past 5 years, I have had to listen to how every “instant gratification” strategy employed by the government or the Fed has been the right decision. The justification for so many policies has been “it would have been worse otherwise”. That seemed to be the only test of a policy. Would it have been worse otherwise? What a stupid way to run a country.

Now we face the consequences of many of those actions. Those policies that made things last bad at the time all cost money. The debt piled on to pay for those policies is now hurting us. It isn’t just limited what we can do, but it has created the fiscal cliff. Frankly it serves us right.

A billion here, a few billion there and it all added up. Sure it made things less bad at the time, but we have NO CLUE WHETHER THINGS WOULD BE BETTER NOW had we not spent that money. We didn’t take that other path, so we will never know if there were better ways to deal with the crisis, ones that left us with more flexibility so that we weren’t forced with debt ceiling, sequestration, or fiscal cliff.

Would Austerity by another name smell like Fiscal Cliff?

We took the road we took. We made the decisions we made, and I’m realistic to know we would make those same decisions again. Stopping immediate pain is the only long term strategy we have, which isn’t a strategy at all (that sounds Orwellian, or something some college kid says at 3 am in a smoke filled dorm room).

So far, the politicians have been atrocious since the election. Party lines are being drawn and they can barely say bipartisan let alone act like they mean it. Watching Obama the other day reminded me of the old Happy Days episode where the Fonz has to say “sorry” and can’t do it. I thought his speech was a disappointment and I have little doubt that the Republicans will now come up with an even more divisive policy. Maybe a lot is finally priced into the markets and they can’t do much more damage, but I am nervous.

The funny thing is that any outcome is some form of austerity. The same austerity that we say is killing Europe. I don’t always agree with Krugman the epitome of debt doesn’t matter and spend spend spend, but right now, maybe the government needs to be listening to him?

Some Radical New Thinking

The politicians seemed to have picked sides and are negotiating along those lines. Team no spending cuts versus team no taxes. I heard that Bravo was thinking of doing a reality TV series on that basis but thought it was too unrealistic because no people could be so stubborn or narrow minded. CSPAN thought about doing a reality series along the same lines and realized they have it, and it is called the U.S. government.

I have gotten lost in the fiscal cliff talk. As far as I remember, a lot of why we have the fiscal cliff, is because of the debt ceiling. Should we just raise the debt ceiling? If one of the major reasons for the fiscal cliff is the debt ceiling, maybe we should be taking a hard look at that. Is now the right time to have this fight, or should we keep policy as is for now? I don’t know the answer to this. In general I think we need to make some hard decisions and get on a sustainable path and that there never is a “good” time to make cuts to spending or to raise taxes. So if there never is a good time, and we need to do it, maybe we are doing the right thing. But even I am open to at least debating that idea. That has to be better than just fighting along ideological lines.

What about off shore cash? Can we offer a simple one time, lowered tax rate to bring it onshore? I’ve heard that proposed before. Not sure I believe it works, but maybe it is worth looking at. It would probably annoy many of our trading counterparties, but making other countries like us seems to be low on our list of priorities anyways.

Then let’s address the root causes and not the symptoms. We can pretend that U.S. policy is what drives the U.S. economy as much as we want, but it just isn’t true. Europe is an anchor around the global economy. Europe heading into recession is not good for anyone. We should be beating on them to get something done, and as sad as it is to say, we should be pushing the IMF to be aggressive.

We can implement austerity measures and watch Europe deteriorate and pretend our deficit will get better in a few years. It won’t. The future budget projections will be based on erroneous assumptions. It is scary that we seem headed down that path (or actually remain on that path since we’ve been on it for years).

Anyways, I’m not feeling optimistic about governments’ ability, but maybe, just maybe there is some upside surprise here.

In Other News

Europe remains a mess. The economy there is getting worse not better. Merkel and Scheuble happily play the harpsichord as the ship goes down, but at least there won’t be any inflation.

From inflation to conflagration which is what we are seeing signs of in Israel. Air strikes and then missiles which leads to what? In other news, the “eye for an eye” foreign policy of the mid-east celebrates its 5000th anniversary next year, if it makes it that long. Will this escalate into something more disruptive for the global economy? I have always felt that this time of year is when the U.S. is least focused (Thanksgiving and Christmas) and the added confusion of an election year where many politicians are killing time until they are replaced in January, makes it an ideal time to stir up trouble elsewhere. The situation in the mid-East is real, is dangerous, and would be a serious threat to an already weak global economy.

Credit Markets

High yield in particular is seeing some real outflows. Bonds are getting cheaper, but selling pressure grew yesterday. A real concern about future profits and defaults or caught up in the risk off trade? I am working on a separate piece for our institutional clients on state of the high yield markets, but I am coming out positive. The one fear that I have is that the ETF’s are trading at a discount, and if that continues (or is real, since NAV is fuzzy for these funds), then we could see an arb driven liquidation/sell-off that has a long way to go. I will update when I’m done with the analysis.

Performance Chasers Ran Into an Oncoming 18 Wheeler

The peak of the “performance chasing money on the sidelines” investment philosophy was back in late September. I ranted about how dumb I thought it was on September 21st calling the “Underperforming hedge fund” logic flawed. I went through some examples. I continued to harp on what a bad idea it was until September 25th.

If a hedge fund was up 5% on September 24th when the S&P was up 15%, and they went all-in (in theory they would need a leverage bet to catch up, but why let math cloud a good sound bite that encouraged investors to go long), that fund is now down 3% on the year and continues to underperform by 10%. Had a fund shorted the S&P (all in) then the fund would now be up 13% and beating the S&P by 6%.

Please remember that the next time the performance chasing investment thesis reaches fever pitch.

It might be worth considering whether the “hedge funds will protect their year” message is getting a little overdone here.